Institutional EYE

Commentary on Corporate Governance Issues

Independent Directors need training, not eligibility criteria

November 27, 2019

The proficiency self-assessment test instituted by the MCA is unlikely to provide any meaningful solution to board strengthening. There is no denying that boards in India need training but understanding technical subjects will not help directors in taking the right decision.

Recent failures have given enough reason to believe that directors need to have greater awareness of their fiduciary responsibilities. Of the recent failures – several on account of corporate governance lapses – had boards with well-established directors that failed in executing their fiduciary responsibilities. IL&FS and CG Power are cases that come quick to mind.

Leave aside abject failures, but governance practices in well established companies also raise questions on the role of Independent Directors. That shareholders have to vote against remuneration resolutions or stock option schemes raises questions on whether the nomination and remuneration committee (NRC) has used objective benchmarks to decide executive compensation. Whistle-blower letters that go directly to the regulator rather than through the company’s own policy and process are, to some extent, a reflection of the trust commanded by the company’s board and leadership. Related party transactions that are defeated centrally question the role of the audit committee and the overall board in exercising independence when approving these transactions.

Will the proficiency test for Independent Directors, instituted by the Ministry of Corporate Affairs in October 2019 (Exhibit 1), address any of these issues? We think not. The test is designed to familiarize independent directors with securities and corporate law, basics of accounting, and “and other such areas relevant to the functioning of an individual acting as an independent director”. It does not attempt to make independent directors think about what is beyond the scope of legal provisions. The target audience is narrow – limited to independent directors with less than 10 years of board or KMP experience. Directors with less than 10 years of aggregate work experience – typically those born in the promoter family and have reached drinking age – do not have to take this test, since they are not independent directors.

The proficiency test is an overlap with the familiarization programmes already being conducted by companies. The Companies Act 2013 mandated companies to hold trainings for directors – which was subsequently rechristened to director familiarization programmes. The idea of this was akin to continuing professional education for directors. The discretion of what trainings to undertake has been left to companies, and companies tend to mix programmes from business related topics, to regulatory updates. Over and above this, directors will now have to take the test. Perhaps it may have been easier to ask companies to ensure at least one session annually covers regulation and regulatory updates – that may have a better outcome.

The implementation of the mandatory test is likely to follow a script we have all seen in the past. While the test has been mandatory, it is a decision that seems to have been made in a hurry: the 22 October 2019 notification essentially requires the test to be made available from 1 December 2019. To get a panel together and create an online test in less than two months is challenging. There is a high probability of the test being postponed, or a hurried implementation with execution difficulties. Once implemented, the exceptions will begin. Listed public sector companies have been the exception to almost every rule – there is little reason to believe that they will comply with this requirement. Reduction of passing thresholds (currently set at 60%), exempting bureaucrats above a certain rank, creating optional questions or sections, et al will likely follow.

In the manner that the proficient test has been designed, it seems to become more eligibility criteria than training. It is one-time; directors take it, pass and they are done. This is not continuing professional education, where directors are kept abreast of changing regulations or changing market expectations. The Ministry of Corporate Affairs will do well to roll-back this entire idea, since its impact on board quality will be nothing more than a check-the-box.

There is no denying that independent directors need training. But the training needs to focus on taking the right decision for all stakeholders – not on ensuring compliance (companies have legal teams for that). Boards need to straddle between taking the right decision and what is legally right; they need to find their own dharma.